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The Federal Reserve Cut Interest Rates 50
Basis Points
Market Comment, 1/30/2008
JANUARY 30TH
FED MEETING COMMENTS: Please, Wake Me
When It’s Over!
U.S. stocks opened the week in a
relatively orderly fashion anticipating the likelihood that the Federal
Reserve would cut its benchmark lending rate by 50 basis points this
week, which it did. The discount rate was also cut by 50-basis points to
3.50%. The Fed funds rate is now 3.0%, still “high” relative to the
1.5%-2.0% annual target. The stock market reacted in a fairly benign
fashion having fully discounted a 50-basis point cut, thereby placing
increased focus on the next Fed meeting. Based on the comments by the
Fed, it appears to us that the Fed has left the window of opportunity
for another rate cut in March pointing to the heightened risk currently
in the financial markets and downside risk to the economy. A 25-basis
point reduction simply would not sit well with investors after the
Commerce Department's report that new-home purchases slid to a 12-year
low, the biggest yearly drop in new-home sales on record (the government
began keeping records in 1963). This announcement was followed by an
8.4% home price-decline in the Case-Shiller Index, the highest number
since Case-Shiller began tallying home prices in 1987. It should be
evident to the Fed that its “trickle” approach is unwelcome and
frustrating. Are these poor housing figures a surprise to anyone?
The pre-Fed meeting market upswing was
propelled by a rally in the shares of financial institutions and home
builders as each sector would benefit from further cuts in interest
rates. Financial shares continued their advance of the past few
sessions on expectations that reduced borrowing costs will boost profits
and help stem some of the pressure on the building sector and other
credit products. The temptation to pick through the rubble may be
overwhelming for some investors. But given the pervasive nature of the
credit problem, financial institutions may be “unable” to reliably clean
up their books by the first or even the second quarters
of 2008. Home builders also gained
on the expectation of lower interest rates. The shares of Lennar Corp.
and Centex Corp., two major homebuilders, rose to their highest levels
since October 2007.
THE HOUSING MARKET: I Haven’t Got Room For
The Pain.
The depressed housing cycle may extend
well past twelve months. Is it too early to be optimistic about
homebuilders? Probably, since there is an extensive inventory of homes
which need to be worked off once the stalled buyer-lender dynamics can
be re-established. We are not impressed by the rally in financial
institutions either since the full effects of over-extended credit,
which began at the sub-prime level, are likely to have a corollary
fallout on other credit products, namely auto loans and credit cards.
Then there is the difficulty of inducing banks to extend credit on
reasonable terms and consumers’ willingness to borrow. Will a 50-basis
point cut in the central bank’s benchmark lending rate to 3 percent from
its current 3.5 percent serve as the turn-around point for
interest-sensitive sectors? Not likely. Investors may be
confusing pre-Fed meeting stability as a signal that stocks have
bottomed out. On the other hand, the recent up ticks in equities may be
just a fleeting bear-market rally.
FEBRUARY 2008: The Longest Month In The Year.
The next Fed meeting will not be until
early March. So the next move by the Fed will have to last a relatively
long time. In our view, we fear the Federal Reserve has not hit the
interest-rate ball out of the park yet. If, indeed, the goal is to move
the benchmark rate down to 1.5% to 2.0%, the sooner the Fed gets there,
the better. (...they may be on the express track, but they have taken
the local train). In June 2007, Bernanke delivered a speech on the
“financial accelerator,” which describes how weakness in the financial
system can compound an economic downturn. Bernanke explored this theory
in order to describe the depth and duration of the Great Depression.
The unprecedented nature of the fall in real estate values gives this
economic cycle a different quality from other post-World War II cycles,
which were driven by unfavorable trends in inventories, employment and
capital investment. We feel the Fed under Bernanke has failed to fully
comprehend the enormity of the effect the unprecedented collapse in real
estate assets is having on real and perceived total wealth,
dwarfing the pain suffered by the depressed valuation of other assets
held in individual portfolios, specifically stocks.
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